Sense on Cents

July 2009 Market Review

Posted by Larry Doyle on August 1st, 2009 12:20 PM |

In the process of reviewing price action across the entire spectrum of global equity, bond, and commodity markets, I am struck by one simple fact: virtually every market segment went up in value in July. That sort of price action in a challenged economy is uncommon, if not irrational.

Is this price action a sign of an incipient turn in the economy? Will we continue to rally? Are we going to have a V-shaped recovery? Come on back in, the water’s fine? What recession? Hardly.

I continually see the battle royale between the bulls and the bears in the markets. I truly believe we are entering into a new global economic norm and, as such, before we are able to thrive we need to survive. Thus, in my opinion, while others may consider themselves bulls or bears in terms of the markets and economy, I would classify myself as an animal which wants to aggressively survey the landscape, strengthen my reserve, increase my store of value (savings), and judiciously put some small stakes (investments) to work knowing that there remain real risks on the horizon. For lack of a better term, call me a friendly fox.

Without further delay, let’s assess the July 2009 Market Review:

I have added a few indices to take a more comprehensive view of the markets. These indices include: DJ-Global ex U.S., an emerging market index (MSCI), a commodity index, and a U.S. dollar index. I hope readers find these helpful.

Let’s grade my calls from last month, at which point I wrote: Read the rest »

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‘Cash for Clunkers’ Comments and Questions

Posted by Larry Doyle on July 31st, 2009 2:51 PM |

Uncle Sam just spent $1 billion via the “Cash for Clunkers” program over a 4 day time frame. Given the speed of that burn rate, The Wall Street Journal reports, House Votes to Extend ‘Clunkers’ Program.

A few questions and comments:

1. The National Highway Traffic Safety Administration is overseeing the disbursement of these funds. Think there may be a chance of some kickbacks or fraud going on here? Who is checking?

2. Assuming the average list price of the fuel efficient vehicles being sold is $20k, the subsidy of upwards of $4500 is approximately a 20% discount. Is this a true reflection of latent demand or partially a reflection of consumers responding to a gift?

3. What does this program do to the used car market? If I am in the market for a used car, my bid just went down at least 10% if not more.

4. How does this program affect the less fuel efficient car market? Does it strip demand away from that segment?

5. If there is such demand for the Cash for Clunkers program, should there be further restrictions on who may be able to benefit from this program going forward?

6. Given the speed with which the initial $1 billion was utilized, do you think there is a chance car dealers are working other deals with customers?

Not to be overly cynical, but as an industry car dealers do not exactly enjoy the best reputation. As such, while Congress can approve more funds, I would like to see a thorough audit of this program prior to the actual allocation of those funds.

Thoughts and comments welcome.

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IMF Sees U.S. Risks Tilted to the Downside

Posted by Larry Doyle on July 31st, 2009 11:38 AM |

The 2nd quarter GDP report this morning is surprisingly strong at a better than expected -1%. Are we supposed to disregard the significant downward revision (-5.5% to -6.4%) for 1st quarter GDP? Can we go somewhere to get an unbiased macro view of the U.S. economy?

It just so happens the International Monetary Fund released a review of our domestic economy this morning. This report, United States: 2009 Article IV Consultation, provides a rather sobering outlook as we continue navigating our economic landscape.

What do we learn?

>>financial strains are still elevated and the outlook remains for only a gradual recovery, with risks still tilted to the downside.

>>Policies under the Financial Stability Plan, notably the SCAP stress test, debt guarantees, and capital injections, have contributed to a significant improvement in financial conditions. However, risks persist, notably the risk that a prolonged recession could further erode capital. This situation warrants continued close monitoring and regular stress tests to evaluate vulnerabilities. The proposed reserve for stabilization funds should be retained, with the resolution framework for systemic nonbanks expeditiously implemented to improve the predictability and flexibility of crisis management. Balance-sheet cleaning remains a priority; the PPIP will provide a tool, although its usage may be limited. Recent steps to facilitate mortgage modifications are welcome, but more steps may be needed to encourage writedowns of underwater mortgages.

>>Monetary policy should remain highly accommodative until recovery is clearly underway. If downside risks materialize, additional credit easing and a strengthened commitment to maintaining a highly accommodative stance could be deployed. Additional fiscal stimulus could also be used, provided it were set within a credible medium-term fiscal framework.

>>For the Fed, a diverse set of tools will be needed to afford maximum flexibility in light of uncertainties about how market conditions will evolve and about the extent to which particular instruments can be used. In addition, Maiden Lane facilities should be transferred to the Treasury at an early stage, to reduce the Fed’s exposure to credit risk. On support to financial institutions, terms should be tightened on facilities that need to be extended, to avoid distortions, fiscal risks, and governance issues. Clear communication of the strategy would bolster market confidence, and international coordination will be warranted as well.

Recall that Maiden Lane was a facility used by the Fed to house Bear Stearns assets in the process of JP Morgan’s takeover of that firm. Sounds like the IMF has some concerns! Read the rest »

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Does AIG’s Self-Dealing Pose Systemic Risk?

Posted by Larry Doyle on July 31st, 2009 8:04 AM |

While our equity markets are making new highs for the year, I cautioned readers the other day “No Time for Complaceny on Insurance and Money Fund Exposures.” On the insurance front, I specifically highlighted:

Experts Call for Fed Involvement in Insurance Industry — but to Different Degrees; InvestmentNews, July 29, 2009

Members of Congress are being urged to create — at a minimum — a new regulatory body within the federal government to focus on the insurance industry. “There is some systemic risk in insurance requiring a regulator,” said Travis Plunkett, legislative director of the Washington-based Consumer Federation of America, who was part of a panel of experts testifying today at a Senate Banking Committee hearing on modernizing insurance regulation.

“In order to fully understand and control systemic risk in this very complex industry, the federal government should take over solvency and prudential regulation of insurance as well.

Where may this systemic risk within the insurance industry originate? None other than our ward of the state, AIG. We are reminded of the massive systemic risk, if not potential illegal business dealings, occurring at AIG in this morning’s New York Times, which reports After Rescue, New Weakness Seen at AIG:

The dozens of insurance companies that make up the American International Group show signs of considerable weakness even after their corporate parent got the biggest bailout in history, a review of state regulatory filings shows.

Over time, the weaknesses could mean trouble for A.I.G.’s policyholders, and they raise difficult questions for regulators, who normally step in when an insurer gets into trouble. State commissioners are supposed to keep insurers from writing new policies if there is any doubt that they can cover their claims. But in A.I.G.’s case, regulators are eager for the insurers to keep writing new business, because they see it as the best hope of paying back taxpayers.

While insurance in general is a pure statistical risk management business, in AIG’s case writing new business and collecting new premiums to pay off current outstanding liabilities amounts to a Ponzi scheme orchestrated by Uncle Sam. Read the rest »

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Obama’s Lessened Popularity Is Helping the Market

Posted by Larry Doyle on July 30th, 2009 5:12 PM |

What is driving the equity markets higher?

1. an end to the recession?
2. green shoots?
3. better than expected earnings?
4. excess liquidity?
5. all of the above?

How about President Obama’s decline in popularity? In a perverse way, is a lessened approval rating for President Obama, in fact, supporting our markets?

Has the decline been statistically significant? What has caused the decline? Given that we are living in the Sense on Cents designated Uncle Sam Economy, we would be foolhardy to neglect what political polls are saying.

Gallup reports, Obama Approval Slips Three Points in Past Week:

Amidst President Obama’s push in July to revamp the nation’s healthcare system, Gallup finds his average job approval rating registering 56% for the seven-day period ending Sunday, down from 59% the previous week. This three percentage point drop is the largest week-to-week decline seen in Obama’s job approval thus far in his presidency, and punctuates a gradual descent from his 66% rating in early May.

The current week is starting off no better for Obama than the previous one. His job approval score in Gallup Poll Daily tracking, conducted July 25-27, is 54%; this is his lowest individual reading to date. Thirty-seven percent of Americans currently disapprove of the job he is doing and 9% have no opinion. Read the rest »

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Wall Street Compensation Collusion

Posted by Larry Doyle on July 30th, 2009 2:44 PM |

Gaining market intelligence is one thing. Colluding with market participants in business practices is an entirely different issue. The Wall Street compensation process has always operated dangerously close to that line, and would appear to have gone over it in 2008.

This potentially collusive practice is easily disguised in the midst of excessive profitability, but is blatantly obvious when revenues disappear. The Wall Street Journal highlights this practice in writing Banks Paid Big Bonuses as Profits Slid:

Several of the banks hit hardest by the economic downturn and those that got the most U.S. government aid nonetheless handed out huge bonuses to hundreds of employees last year, according to New York Attorney General Andrew Cuomo.

Many of the banks that took money from the U.S. Treasury Department’s Troubled Asset Relief Program had been saying they wanted to pay it back as soon as possible, largely because of restrictions put on compensation that came with the funds.

Many of the banks have already paid the money back, but some, such as Bank of America Corp. and Citigroup Inc., haven’t yet done so. Mr. Cuomo said his office has been investigating compensation at many of the banks, including the original nine banks that took TARP funds, over the past nine months. The study refers to 2008 bonuses — those that would have been paid before any of the banks repaid their government bailout money. Read the rest »

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Don’t Fight the Fed

Posted by Larry Doyle on July 30th, 2009 12:37 PM |

“Cover all your Treasury shorts!!”

I will never forget that mandate put forth by Tom Kirch, then head of Fixed Income at First Boston, as the stock market was crashing in October 1987. As a young trader, moments like that are not soon forgotten. Why? Mr. Kirch through dint of experience knew that you “don’t fight the Fed.”

With the crash of the stock market, the Fed cut interest rates and flooded the system with liquidity. In the process, the U.S. Treasury market had a massive rally. Kirch knew what was going to happen and saved the firm millions in the process. You can rest assured I immediately broke out some ‘Buy’ tickets and covered my Treasury shorts in a heartbeat.

“Don’t fight the Fed” is a tried and true rule of trading on Wall Street. While the bond market can often get overbought or oversold in the midst of a Fed easing or tightening scenario, ultimately if the Fed wants to move rates in one direction or another, it will make it happen.

Fast forward to the Brave New World of the Uncle Sam Economy 2009. How are market participants supposed to view the Fed currently? Dare I say, as challenging as it may be for market participants, myself included, “don’t fight the Fed” is still very much applicable. How so?
Read the rest »

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A Fresh New Perspective on Technology and Electronic Trading

Posted by Larry Doyle on July 30th, 2009 9:14 AM |

Is high frequency program trading inherently unfair? Does it improperly utilize technological advances? Does it allow front-running at point of execution? So many great questions, but to this point, the debate on this topic has completely focused on the equity markets.

Well, let’s shift the focus of this debate to the debt markets, commonly regarded as the bond or fixed income markets. What can we learn by comparison? Do the fixed income markets represent a fair comparison? As with any comparative analysis, do we have sufficient data to analyze and compare these markets? Non-financial people may be surprised, but the debt market across all sectors totally dwarfs the equity market in terms of size. Let’s frame the debate.

I view technological developments on the investment superhighway as having three lanes: analytics, risk management, and trade execution.

Whether in fixed income or equities, technology which can more efficiently and productively provide robust analytics is a great advantage and should be embraced. As a case in point, when I traded mortgage securities throughout the ’80s and ’90s, Bear Stearns invested in and utilized tremendous analytics. The Bear system was so advanced that it could literally analyze the mortgages in a mortgage-backed security to the level of the underlying zip code. No other dealer had those capabilities and it was a boon to Bear’s business. This technology was utilized to run a wide array of customer portfolio optimizations and helped Bear become the top mortgage shop on Wall Street. Bear’s downfall is a story for another time. The point being, technology which can more thoroughly review an investment product promotes competition and capitalism. There should be no speed limit on this technology lane of the investment superhighway. Read the rest »

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Economy and Markets: Improving, Declining, or Adapting?

Posted by Larry Doyle on July 29th, 2009 3:35 PM |

While the dark economic storm clouds of 2008 may have passed, the economic outlook and landscape remain decidedly mixed as evidenced by the recently released Federal Reserve Beige Book. The key takeaways in this report include:

>> slower pace of overall economic decline

>> expectations of a moderate recovery in manufacturing in 6-12 months

>> extended soft labor market

>> sluggish retail sales

>> commercial real estate weakened in most regions

>> some pockets of strength in technology and health care

>> credit conditions remained extremely tight. Loan demand experienced a downturn, particularly from the household sector. Credit standards continue to tighten as delinquency rates are steady to higher.

>> a pickup in used car sales (don’t think this is a positive)

Bloomberg reports Fed Says Most Districts Report Slower Pace Decline:

The Beige Book provided few signs of outright growth. Retail demand was “sluggish” in most areas, with “mixed” auto sales. Non-financial services were “largely negative” with “a few bright spots,” and manufacturing was “subdued” yet “slightly more positive” than in the previous report, the Fed said.

Lending in most regions “was stable or weakened further” in most loan categories, and banks tightened credit standards in seven districts, the report said.

While most economists and market analysts are looking at statistics and data to determine whether the economy and consumers are improving or rolling over, my take is different. I view the economy and consumers as adapting to the new dynamic at work in our country. The color about consumers purchasing more used vehicles is a perfect case in point.

Automotive companies aren’t going to prosper with consumers purchasing more used vehicles, but consumers will continually look for means to save money and keep expenses down.

In regard to market news, this morning I addressed concerns in a post, “What is China Saying? Sustainability and Indirect Bidding,” regarding the level of indirect bidders in our Treasury auctions. I wrote of yesterday’s 2 yr note:

While Chinese officials made these strong statements regarding our deficit, the U.S. Treasury auctioned $42 billion in 2 yr notes. How were these notes received? Not very well. In fact, the indirect bidders only purchased 33% versus close to 69% a month ago.

Today’s $39 billion 5 yr note was not well received, either. Indirect bidders purchased 37% versus 63% a month ago.

As we continue to navigate our economic landscape, I remain convinced that those who are able to most effectively adapt to the dynamic changes will be in the best position to thrive as we move forward.

What do I mean by adapting? Continue to work to keep expenses down, be judicious and disciplined in your investments, and be voracious in terms of absorbing data on the economy, markets, and companies.

It goes without saying a healthy dose of Sense on Cents as part of your daily diet is also strongly recommended!!

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No Time for Complacency on Insurance and Money Fund Exposures

Posted by Larry Doyle on July 29th, 2009 1:02 PM |

Despite the rise in the equity markets and supposed hints of stability in the economy, this is no time to get complacent about your investments. The transition we are experiencing in the economy and the markets will present real opportunities, but also real risks.

On the topic of risks, it is of paramount importance that all investors get full information from your brokers and financial planners across all your exposures. Do not allow those managing your money to indicate ‘the market feels OK here’ and leave it at that. Why? Significant underlying fundamental risks remain in the market. I am reminded of two of them this morning as I read the following about insurance companies and money market funds:

1. Experts Call for Fed Involvement in Insurance Industry — but to Different Degrees; InvestmentNews, July 29, 2009

Members of Congress are being urged to create — at a minimum — a new regulatory body within the federal government to focus on the insurance industry. “There is some systemic risk in insurance requiring a regulator,” said Travis Plunkett, legislative director of the Washington-based Consumer Federation of America, who was part of a panel of experts testifying today at a Senate Banking Committee hearing on modernizing insurance regulation.

“In order to fully understand and control systemic risk in this very complex industry, the federal government should take over solvency and prudential regulation of insurance as well.

This shift in regulatory oversight of the insurance industry would be a massive undertaking. Recall that all insurance companies are currently regulated at the state level; however, state insurance reserves to protect policyholders against defaults are woefully deficient.

The Wall Street Journal touches upon this as well, in writing Syntax Error? Life Insurers and Earnings:

Some life insurers used the recent market upturn to raise more than $10 billion in combined capital. Hartford Financial Services Group and Lincoln National, which report after the market closes Wednesday, accepted Treasury Department money. The injections have scaled back doomsday scenarios, as well as liquidity concerns that made a few insurers short-selling favorites.

At Hartford and Lincoln, analysts are watching closely to see if the government bailouts may be tainting the insurers in consumers’ eyes.

While certain banks were forced to take TARP money, for Hartford and Lincoln taking TARP became a necessity. If I had exposure to these institutions, I’d be monitoring them very closely. I’d do the same with all my insurance exposures.

2. Money Funds Are Ripe for ‘Radical Surgery’; Bloomberg News; Jane Bryant Quinn writes:

I’m among the last people standing who think that Paul Volcker is right about money-market mutual funds. They pose a systemic risk to the financial system and need a radical fix.

When a central banker of Volcker’s magnitude raises a concern of systemic risk, I am all ears. Virtually the entire money market industry is currently backstopped by Uncle Sam. How many of these money funds may ‘break the buck‘ without some form of assistance? Bryant asserts:

In most cases, money-fund sponsors have come to the rescue of their funds if any question arose about the $1 value of their shares. Peter Crane, president and founder of Crane Data LLC in Westboro, Massachusetts, says as many as one-third of the funds will have needed support by the time this global financial squeeze abates.

But you can’t be sure that sponsors will always be willing or able to bail out their shareholders, says Jack Winters of Hingham, Massachusetts, an expert who worked in the industry from 1976 to 2008 and commented on the SEC proposals.

“Dealers supported auction-rate securities for 25 years until their financial situation precluded it,” Winters says.

We know all too well how the ARS debacle unfolded.

No time for complacency!!

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The Buck Is Beginning to Break

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